Declining liquidity

At this late stage, a company has normally suffered serious damage. It is unable to meet its financial commitments, has lost stakeholder support, needs funding urgently, and is in serious need of corporate renewal to fix the company.

Unfortunately, it is often only at the stage of a liquidity crisis developing that shareholders intervene in the underperforming or distressed company with serious intent.

If they are unwilling or unable to do so, turnaround or bankruptcy is triggered by creditors, either lenders e.g. banks concerned about the inability of the business to service loans, or suppliers acting on non-payment of their invoices.

Cash flow measures

EBITDA (EBIT with depreciation and amortisation added back) - this is a good proxy for operational cash flow - if it is positive it indicates that problems lies with working capital management or gearing.

EBITDA margin (EBITDA/turnover).

Cash retention (net income after interest and tax before depreciation and amortisation) - an extremely useful proxy for bottom-line cash flow, especially for companies reporting distorted figures through capitalising expenses.

Cash retention ratio (Cash retention/turnover).

Free cash flow (cash flow after investment in/disposal of assets and movement in working capital, but before shareholder and debt financing i.e. before equity investment, dividends, loans, loan repayment and interest payments) - used in discounted cash flow calculations and to determine debt repayment programmes.

Solvency measures

Note that Gearing will also impact on the interest cover (see Debt Servicing Measures).

Debt servicing measures

Interest cover (PBIT/interest charge) - indicating the ability of the company to service its interest obligations.

Short-term debt cover (short-term debt and interest payable/cash retention) - indicating the ability of the company to service its short-term debt obligations - a useful measure for short-term survivability.

Debt cover (interest-bearing debt/cash retention) - indicating the ability of the company to service its debt obligations - a useful measure to predict company failure (but not as good as the Z-Score).